PFICs discusses the passive foreign investment company (“PFIC”) provisions. These provisions attempt to deny the benefit of tax deferral to U.S. persons who invest in PFICs, i.e., foreign corporations that generate primarily passive income but whose investors are not subject to the anti-deferral rules for controlled foreign corporations (“CFCs”). While there have been as many as six anti-deferral regimes, after 2004 the PFIC provisions comprise one of the two remaining anti-deferral regimes (along with the CFC rules).
Written by Thomas A. O'Donnell, Esq. of Baker & McKenzie, Zurich, and Ozzie A. Schindler, Esq. of Greenberg Traurig, this detailed analysis contains a complete overview of the subject matter as well as in-depth analysis including
As discussed in PFICs , a foreign corporation is a PFIC if it satisfies either of two tests — an income test or an asset test. Under the income test, a foreign corporation is a PFIC if 75% or more of its gross income is passive income. Under the asset test, a foreign corporation is a PFIC if 50% or more of the average value of its assets consists of assets that would produce passive income. For purposes of both tests, certain look-through rules apply.
There are three possible taxation regimes under the PFIC provisions — the “default” regime and two elective regimes. Under the excess distribution regime, which is the default regime, an interest charge is imposed on the U.S. tax on excess distributions from a PFIC. Under the qualified electing fund (“QEF”) regime, a U.S. investor is taxed under rules similar to the CFC inclusion rules. Under the mark-to-market regime, which applies to marketable stock in a PFIC, the U.S. investor marks its stock to market on an annual basis.
If the U.S. investor fails to elect the QEF regime or the mark-to-market regime in the first year PFIC stock is held, but subsequently elects one of those regimes, both the interest charge regime and the elective regime may apply simultaneously unless the investor “purges the PFIC taint.” This may be accomplished by a deemed sale or, if the PFIC is a CFC, by treating all earnings and profits earned during the period of PFIC status (while the investor held the stock) as an excess distribution.
PFICs allows you to benefit from:
This Portfolio is part of the Foreign Income Portfolios Library, a comprehensive series containing more than 90 Portfolios, which covers critical transactions and issues in international taxation. This highly-regarded resource service offers commentary on a wide range of foreign income topics including: Foreign Tax Credit, Business Operations in more than 40 foreign countries, Branch ProfitsTax, Source of Income Rules, Subpart F (Controlled Foreign Corporations), Foreign Partnerships and Partners, Transfer Pricing, and more.
Detailed Analysis
I. Overview of PFIC Provisions
A. Background
B. Legislative History of PFIC Provisions
C. Impact on U.S.-Based Multinationals
D. Scope of the PFIC Regime Compared to Other Anti-Deferral Regimes
1. CFC Provisions (§ § 951-64)
2. Former Foreign Personal Holding Company Provisions (§ § 551-58)
3. Personal Holding Company Provisions (§ § 541-47)
4. Former Foreign Investment Company Provisions (§ § 1246-47)
5. Accumulated Earnings Tax Provisions (§ § 531-37)
E. Determination of PFIC Status
F. Taxation Under the PFIC Provisions
1. Excess Distribution Regime
2. QEF Regime
3. Mark-to-Market Regime
4. Overlap Between Excess Distribution and QEF Regimes
G. Ineligibility for Special Dividend Tax Rate
II. Determining PFIC Status - § 1297
A. In General
B. Income Test
1. Inapplicability of CFC Exclusions
2. Exceptions Contained in § 954(c)(2)
3. Section 954(c)(3) "Same Country" Exception
4. Section 954(c)(4) Look-Through for Certain Sales of Partnership Interests
5. Section 954(h) and (i) Active Banking and Insurance Income Exceptions
6. Notice 88-22
C. Asset Test
1. Applied on Gross Basis
2. Average Value
3. Adjusted Basis Versus Fair Market Value
a. Special Rule for Lessee of Tangible Personal Property
b. Special Rule for Research and Experimental Expenditures
4. Characterization of Assets
a. General Rule
b. Split Character Assets
c. Depreciable Property Used in a Trade or Business
d. Trade or Service Receivables
e. Intangible Assets
f. Working Capital
g. Stock and Securities
h. Tax-Exempt Assets
D. Look-Through Rules
1. In General
2. Subsidiary Look-Through Rule
a. In General
b. Income from Subsidiary and Related Assets Disregarded
c. Effects of Subsidiary Look-Through Rule
d. Value of Assets Versus Value of Stock
e. Indirect Ownership
f. Examples - Asset Test
(1) Direct Ownership
(2) Indirect Ownership
g. Examples - Income Test
3. Related Person Look-Through Rule
a. Character of Assets and Income
b. Examples
4. Domestic Corporation Look-Through Rule
5. Interaction of Look-Through Rules
E. Classification of Income and Assets in Respect of Partnership Interests
F. Exceptions
1. Active Banking Business Exception
b. Active Foreign Bank
(1) Banking Activity Test
(2) Gross Income Test
(3) Licensing Requirement
c. Bona Fide Banking Activities
d. Characterization of Income
e. Characterization of Assets
f. Other Foreign Corporations
g. 1995 Proposed Regulations
2. Insurance Income Exception
3. Start-Up Year Exception
4. Change of Business Exception
5. Former § 1247 Corporation Exception
6. Active Securities Dealer Exception - Repealed
7. Foreign Trade Exception
8. Exception for U.S. Shareholders of CFCs
G. Unexpected PFIC Status
1. Sales and Service Companies
2. Manufacturing Companies with Losses
H. Overlap with Other Anti-Abuse Regimes
1. CFC Rules
2. Former Foreign Personal Holding Company Rules
3. Former Foreign Investment Company Rules
I. Information Reporting Requirements
III. Attribution Rules - § 1298(a)
B. Corporations
C. Partnerships, S Corporations, and Estates
D. Trusts
1. "Proportionate" Ownership through Trusts
b. No Presumed Discretion in Favor of U.S. Persons
c. Present Versus Remainder Interests
d. Actuarial Interest
e. Facts and Circumstances Approach
2. Discretionary Trusts and Letters of Wishes
E. Option Rule
F. Successive Application
IV. Excess Distribution Regime - § 1291
A. Overview
B. Determining Amount of Excess Distribution
2. Gains on Disposition
a. Direct, Indirect or Deemed Disposition
b. Nonrecognition Transfers
(1) General Rule and Scope
(2) Basis and Holding Period
(3) Exceptions to Gain Recognition
(a) Exception for Transfers of § 1291 Fund Stock for PFIC Stock
(b) Exceptions for Transfers to U.S. Persons
(c) Exceptions for Transfers Involving Pass-Through Entities
(d) Transfers to Nonresident Alien Spouses Filing Joint Returns
(4) Special Rules
(5) Information Reporting Requirements
(6) Effective Date Issues
(7) Interaction with § 1291(e)
c. Installment Sales
d. Series of Liquidating Distributions
e. Coordination with § § 367 and 1492
3. Actual Distributions
b. Definition of Distribution
(1) In General
(2) Coordination with Current Inclusion Rules
(3) Section 304 Transactions
c. Prior Excess Distributions Partially Disregarded in Determining Base Period Average
d. Distributions in Current Year Cumulated
e. Distributions to Predecessors in Interest
f. PFIC Stock Not Held for Entire Year
g. Distributions in Current Shareholder Year Prior to Acquisition of PFIC Status
4. Gross-up for Creditable Foreign Taxes
C. Allocation of Excess Distributions to Holding Period
2. Holding Period Rules
b. Special Holding Period Rules
c. PFIC Character of Holding Period
3. Multiple Distributions in Current Year
4. Shares Purchased on Different Dates
D. Taxation of Excess Distributions
a. Portions Allocable to Current Year and non-PFIC Periods
b. Determining the Deferred Tax Amount for the Prior Year PFIC Period
c. Step 1 - Aggregate Increase in Taxes
d. Step 2 - Aggregate Amount of Interest on Increases in Taxes
e. Step 3 - Deferred Tax Amount
f. Summary of Examples
2. Use of Credits to Offset Deferred Tax Amount Liability
3. Section 453A(c) Interest
E. Foreign Tax Credit for Excess Distributions
1. Introduction
2. Pre-TAMRA Foreign Tax Credit
3. Overview of Procedure for Determining Post-TAMRA Foreign Tax Credit
a. Step 1 - Determine Creditable Foreign Taxes
b. Step 2 - Determine Foreign Taxes Allocable to Excess Distributions
c. Step 3 - Allocate Excess Distribution Taxes
d. Step 4 - Pre-PFIC and Current Year Periods
e. Step 5 - Prior-Year PFIC Period
4. Foreign Tax Credit Issues in the Case of Actual Distributions
a. Nonexcess Distributions
b. Excess Distributions
5. FTC Treatment of Excess Distributions Arising from Gains on Disposition
6. Other Aspects of the FTC Rules for Excess Distributions
a. Separate Basket for Each PFIC
b. No Carryover of Excess FTCs
c. Prior Law - Sub-Baskets for Each CFC/PFIC
d. Deferred Tax Amount FTCs Offset the Interest Charge
e. Prioritizing Offsets of Deferred Tax Amounts
7. Example
F. Deemed and Indirect Dispositions and Distributions
1. Deemed and Indirect Dispositions of PFIC Stock
a. Dispositions by Intermediate Entity
b. Disposition of Interest in Intermediate Entity
c. Deemed Dispositions
d. Exceptions
e. Amount and Treatment of Indirect Dispositions
(3) Basis and Holding Period
2. Indirect Distributions
b. Exception for Distributions to Sole Shareholder
c. Adjustments to Basis
3. Coordination with Actual Distributions and Dispositions
4. Special Information Reporting Requirement for U.S. Partnerships and S Corporations
5. Pledge of PFIC Stock
b. Indirect Pledge
c. Basis and Holding Period
d. Transition Rule for Pre-1987 Pledges
G. Miscellaneous Rules
1. Adjustments for Stock Splits and Stock Dividends
2. Incorporation of § 1246 Anti-Avoidance Rules
a. Substituted Basis Stock Inherits PFIC Stock Attributes
b. Stock in Certain Non-PFIC Entities Treated as PFIC Stock
c. Stock Acquired from Decedent
d. Decedent Dying During 2010
e. Information Reporting for 5% Shareholders
3. Foreign Currency
H. Unusual Features of the Excess Distribution Rules
1. Taxation of Return of Capital
2. Loss on Disposition
3. Excess Distribution for Prior PFIC Years Is Not Gross Income
b. Ancillary Effects
4. Recharacterization of Pre-1987 Gain on Disposition
5. Distributions of Tax-Exempt Income
6. Reduction of Earnings and Profits
I. Change in Residence or Citizenship for Aliens
1. Inbound Changes
2. Outbound Changes
J. Interaction with CFC Rules
1. Overview
2. "Qualified Portion"
3. Continued Application of PFIC Rules to U.S. Shareholders of CFC/PFICs Under "Once a PFIC, Always a PFIC Rule"
4. Effect of Loss of CFC Status
5. Securities Dealers
6. Effective Dates and Taxable Years
7. Basis Adjustments for Previously Taxed Income
K. Coordination of Excess Distribution Rules with Other Code Rules
1. Coordination with § 1248
2. Coordination with Former Foreign Personal Holding Company Rules
3. Coordination with Former Foreign Investment Company Rules
4. Coordination with Taxation of Certain Trusts
a. Pooled Income Funds
b. Charitable Deductions for Trusts
5. Coordination with QEF Rules
6. Special Rules for Regulated Investment Companies
L. "Once a PFIC, Always a PFIC"
2. Avoiding the Rule
a. QEF Election in First Year of PFIC Status
b. Marking PFIC Stock to Market and Treating Gain as an Excess Distribution
c. Mark-to-Market Election for Marketable Stock
d. Recognizing Post-1986 Earnings and Profits of Controlled Foreign Corporations
M. Annual Distribution of All Profits
N. Information Reporting Requirements
V. Mark-to-Market Election to Include Gain or Loss from Publicly Traded PFIC Stock - § 1296
B. Legislative History
C. Marketability
1. Regularly Traded on a Qualified Exchange or Other Market
a. Regularly Traded
b. Qualified Exchange or Other Market
2. Other PFIC Stock Not Regularly Traded
3. Options on Marketable PFIC Stock
D. Taxation of U.S. Investors
2. Unreversed Inclusions
3. Basis Adjustments
4. Character of Mark-to-Market Gain and Holding Period
5. Source of Mark-to-Market Gain
6. Termination or Suspension of PFIC Status
E. Indirect Ownership Rules
F. Special Rule Where PFIC Stock Held Through CFC
G. Unpedigreed Funds
H. Special Rule for Marketability in the Case of PFIC Stock Held by a RIC
I. Stock Acquired from a Decedent
J. Coordination with Other Mark-to-Market Regimes
K. Coordination with QEF Election
1. Termination of QEF Election
2. Special Rule for Re-Electing QEF Status After Termination Due to Mark-to-Market Election
L. Election Requirements
VI. Electing QEF Treatment - § 1295
B. In General
C. Election Made by the U.S. Investor
D. Time for Making Election
2. Retroactive Elections
E. Manner of Making the Election
2. Annual Election Requirements
3. PFIC Annual Information Statement
4. Annual Intermediary Statement
5. Combined Statements
F. Revocation, Termination, or Invalidation of QEF Election
2. Revocation with IRS Consent
3. Failure to Satisfy Compliance Obligations
G. Effect of Changes in Stock Ownership on QEF Election
H. Proposed Special QEF Election for Preferred Shareholders
1. Making the Special QEF Election
2. Annual Inclusion Rules for Electing Shareholders
VII. Income Inclusions Under the QEF Regime - § 1293
B. Inclusion of PFIC Income
1. Earnings and Profits
b. Exclusions from Earnings and Profits
(1) High-Tax Kickout
(2) Effectively Connected Income
c. Ordering of Distributions
d. Other Adjustments to Earnings and Profits
(1) Distributions of Previously Included Earnings
(2) Section 78 Gross Up
(3) Foreign-to-Foreign § 332 Liquidations
e. Tax-Exempt Interest Income
2. Division of Earnings and Profits Between Ordinary Earnings and Net Capital Gains
3. Pro Rata Share
C. Actual Distributions from PFIC
2. Foreign Currency Gains and Losses on Distribution of Previously Included Earnings
D. Basis Adjustments
2. Indirectly Owned PFIC Stock
3. Adjustment for Deemed Distributions on Loan to Investor
E. Prevention of Double Taxation
F. Foreign Tax Credit
1. Source of QEF Inclusions
2. Characterization of QEF Inclusions Under § 904(d)
a. Prior Law - U.S. Shareholders in CFCs
b. Corporate Shareholders in Noncontrolled § 902 Corporations
c. Other Investors
3. Section 78 Gross Up
4. Gains on Disposition
G. Gains on Disposition of PFIC Stock
H. Coordination with Other Code Rules
2. Section 1248
3. Former Foreign Personal Holding Company Rules
4. Former Foreign Investment Company Rules
5. Taxation of Pooled Income Funds
6. Overlap Between Excess Distribution and QEF Regimes
I. Treatment of Current Losses
J. Information Reporting Requirements
VIII. Election to Defer Payment of Tax on Undistributed QEF Inclusions - § 1294
B. Election Not Permitted
C. Election Made on a Year-by-Year Basis
D. Undistributed PFIC Earnings Tax Liability
2. Definition of "Undistributed PFIC Earnings Tax Liability"
3. Definition of "Undistributed Earnings"
b. Effect of Loan, Pledge, or Guarantee
4. Examples
E. Bond May Be Required
F. Procedural Matters
1. Making Election
a. Time for Election
b. Manner of Making Election
2. Suspension of Statute of Limitations
3. Annual Reporting Requirement
G. Termination of Deferral
1. Distribution of Previously Included Earnings
2. Transfers of PFIC Stock
b. Exception for Nonrecognition Transfers
3. Revocation of QEF Election or Termination of PFIC Status
4. Failure to Comply
5. Jeopardy
6. Direct or Indirect Loan to the Investor
7. Use of PFIC Stock as Security for Loan
8. The Departing Alien
IX. Purging the PFIC Taint - § § 1298(b)(1) and 1291(d)(2)
A. "Once a PFIC, Always a PFIC"
2. Exception Where QEF Status Elected for All Years of PFIC Status
3. Exception Where Mark-to-Market Election Applies
B. Simultaneous Application of Both Excess Distribution and QEF Rules - the Case of the Unpedigreed QEF
C. Purging the PFIC Taint
1. Mark-to-Market Purge Election
a. Where the Foreign Corporation Is No Longer a PFIC
b. Where Foreign Corporation Remains a PFIC and Pedigreed QEF Status Is Desired
(1) Qualification Date
(2) Time and Manner of Making the Election
2. Deemed Dividend Purge Election for U.S. Investor in CFC/PFIC
a. Where Foreign Corporation Remains a PFIC and Pedigreed QEF Status Is Desired
(2) Pro Rata Share of Post-1986 Earnings and Profits
(3) Time and Manner of Making Deemed Dividend Purge Election
b. Where the Foreign Corporation Is No Longer a PFIC
Working Papers
Table of Worksheets
Worksheet 1 1986 Tax Reform Act Conference Report
Worksheet 2 1986 Blue Book (General Explanation of the Tax Reform Act of 1986)
Worksheet 3 1988 TAMRA House Report
Worksheet 4 1988 TAMRA Conference Report
Worksheet 5 1997 Blue Book (General Explanation of Tax Legislation Enacted in 1997)
Worksheet 6 Notice 88-22, 1988-1 C.B. 489
Worksheet 7 Form 8621 - Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund
Worksheet 8 PFIC Annual Information Statement
Bibliography
OFFICIAL
Legislative History:
Treasury Rulings:
Cases:
UNOFFICIAL
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Periodicals:
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